With nod to grim past, fund managers look ahead

SamMamudi

CHICAGO (MarketWatch) -- Mutual-fund managers addressing the Morningstar Investment Conference are grappling with the recent market chaos and trying to plot a path ahead. And while they acknowledge the struggles of late last year, many are hopeful -- even bullish -- about the opportunities they see.

"The reset button was hit in September," said Tom Marsico of Marsico Capital Management, speaking of the dramatic fall in stock prices following the bankruptcy of Lehman Brothers Holdings in September. "Valuations, especially in financials, are as compelling as I've ever seen."

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Even managers who question the strength of the recovery are sniffing out bargains.

Jeff Mortimer, chief investment officer at Charles Schwab Investment Management, said that as early as March 13, his team changed its approach to stocks. He added that March 9 was a bottom which may be retested, but should hold. In Schwab Balanced Fund
SWOBX, -0.93%
the percentage of stocks has increased since March, he added.

"The market is clearly saying the worst may be behind us," Mortimer said, "though that doesn't mean good times are ahead."

"You just keep going, keep doing the [investment research] work, and when the math is compelling you've got to buy [a stock]," said David Winters, manager of Wintergreen Fund
WGRNX, -0.61%
speaking at a panel session.

The participants of a panel of value-focused managers, including Marty Whitman of Third Avenue Funds, were defiant about their heavy losses last year. Whitman's Third Avenue Value Fund
TAVFX, -1.49%
was down 45.6% in 2008.

"It was a market fleeing from the asset class, and not correcting or rebalancing at all," said Bill Nygren, manager of Oakmark Fund
OAKMX, -1.67%
"[Value managers] don't add value in that market."

More than one manager called last year's crash "irrational," caused by forced-selling, particularly among hedge funds and quantitative managers, and overstated fears. The value managers said that they haven't changed how they approach their stock-picking strategies, despite last year's heavy losses.

Different times

One question frequently asked among the financial advisers and investment professionals at the Morningstar conference is whether the crash will push funds to make wholesale changes.

Yet many managers see business as usual once the recovery gets underway, either later this year or in early 2010, but some did see potentially different times ahead.

"If [the downturn] lasts another year or two, you could see the fear of debt and aversion to stocks that we saw after the 1930s," said Wally Weitz, of the Weitz Funds. "But I think that it's more likely [the market recovers sooner and] consumers will be back to over-borrowing and over-spending."

One change that may be lasting is the extent -- and impact -- of government involvement in the markets, said Bill Gross, co-chief investment officer of bond mutual-fund giant Pimco and manager of Pimco Total Return Fund
PTTAX, +0.19%

This new economic climate should prompt investors to question many previously held assumptions -- especially about whether stocks will outperform bonds, and what this means for their portfolios. Figures show that over certain time cycles, bonds have outperformed stocks. See related story.

In a world of more regulation, private-sector deleveraging and less consumption, "it's hard for [Pimco] to imagine" the Dow Jones Industrial Average
DJIA, -1.24%
climbing back to 14000 or home prices returning to 2006 levels, Gross said.

"There's been a structural shift where government [involvement] globally has changed the dynamics of behavior and risks of asset classes," added Vineer Bhansali, head of analytics for portfolio management at Pimco. It's now tougher to determine asset allocations for portfolios because "you have to incorporate the actions of governments," he said.

Bhansali said that one change that he believes will be lasting is using risk management, rather than historic expectations of returns, to determine asset allocation.

"Risk management gives you different answers and it lets you focus on what you can control," said Bhansali.

For example, a balanced portfolio with 60% in stocks and 40% in bonds could actually have 80% equity risk if the bond portion comprises corporate and mortgage-backed securities, he said.

Another change seen last year was a move to cash.

"We raised cashed for some clients for the first time ever," said Mark Balasa, a financial adviser at Balasa Dinverno Foltz and Hoffman in Itasca, Ill. The move was done in part to placate clients who were agitated by the losses and were in danger of pulling out of the markets altogether.

"It gave emotional relief to clients and kept them in the game," he said.

"When you need it most, asset allocation won't work," because market falls can typically hurt all classes, Schwab's Mortimer added. But, he said, once investors do pick an allocation "they can live with" it's important to stick with it. Bull markets typically make more than 50% of their returns in their first year, he added, and investors who to flee the markets are liable to miss out on much of the rebound.

"If you wait to see if the economy and the markets have turned, it's too late," said Meggan Walsh, manager of AIM Diversified Dividend Fund
LCEAX, -1.00%

Pushing on

Some managers also spoke about companies that they like even in these choppy markets.

Rajeev Bhaman, manager of Oppenheimer Global Fund
OGLYX, -1.33%
said one of his favorites is Aflac Inc.
AFL, -1.22%
-- "a wonderful company" -- in part because unlike many other insurers it didn't buy into subprime bonds looking to make extra returns.

Bhaman said that he also like companies that have good prospects of flourishing in emerging markets.

"Luxury goods and staples are favorites of mine," he said. For instance, for the growing affluent class in the emerging markets, LVMH Moet Hennessy Louis Vuitton
LVMUY, -0.43%
will be "leaps and bounds" ahead of local firms because of its reputation. Similarly, he named Colgate-Palmolive Co.
CL, -0.88%
due its growth prospects in India.

"Colgate is the leading toothpaste company in India, but only one-third of Indians use toothpaste right now," Bhaman said.

Colgate and Louis Vuitton are examples of wide moat stocks that are at "unprecedented' low price-to-earnings ratios of 10 or 11.

Another company with a wide moat in India is Nokia
NOK, -1.73%
said Diana Strandberg at fund company Dodge & Cox. The cellphone maker has a "big distribution moat" in India, said Strandberg.

"You need to focus on cash flow and what gets to shareholders," Bhaman said. "Ask lots of questions, especially about the balance sheet, and look at the reality of the money."

Despite the aggressive sentiments, many managers said they wouldn't soon forget last year's experience.

"Every morning you'd wake up and wonder which financial pillar had disappeared," Weitz said. "It would have been fun if it hadn't been so terrifying."

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